TORM: Further Increase In Charter Equivalent Rates Would Mean Higher Stock Price (TRMD)

Front view of large blue merchant cargo ship in the middle of the ocean. Performing cargo export and import operations.

Denys Yelmanov

TORM plc (NASDAQ:TRMD) delivered impressive Q2 2022 time charter equivalent rates, and indicated even better results for Q3 2022. In my view, with further investments in new vessels and scrubbers, future revenue will likely increase. Even considering potential accidents, maritime safety threats, and changes in regulations, in my view, the stock remains undervalued at the current price. I don’t think that the current market valuation includes the expected free cash flow expected for the years 2023 and 2024 by the investment community.

TORM

TORM presents itself as a successful product tanker shipping company founded in 1889, having significant expertise in the shipping industry.

I want to draw the attention towards TORM because of its most recent reports and financial guidance. In Q2 2022, TORM obtained time charter equivalent rates that were two times of time charter equivalent rates in Q2 2021. Let’s also mention that in Q3, the company also noted an impressive increase in rates as compared to that in 2021.

In the second quarter of 2022, Torm realized TCE rates which were more than twice as high as in the same period of 2021. This enables Torm to distribute USD 47m to our shareholders as dividends. The market has continued to improve into the third quarter of 2022, and so, far we have achieved rates which are more than three times as high as those we achieved in the third quarter of 2021. Source: Interim Results Presentation

Quarterly Report

Quarterly Report

It is also quite relevant noting that from 2019 to 2022, the company invested a significant amount of money in new vessels. In my view, companies that expect beneficial times for their industry and operations make meaningful investments like TORM did.

Quarterly Report

Quarterly Report

I could also identify an increase in the amount of shares traded in the market, which clearly indicates that there is demand for the shares. In my view, most investors appreciated the guidance and the most recent returns obtained by TORM PLC.

Quarterly Report

Quarterly Report

Beneficial Outlook For 2022 And Financial Analysts Expect Positive FCF/Sales From 2022

In my view, the financial outlook for 2022 given by management is overall beneficial. TORM expects higher rates in 2021 than that in 2022. Besides, the fact that TORM already covered a significant amount of the remaining earning days in 2022 is quite promising. With this in mind, I would say that the company is successfully working on reaching its financial objectives for 2022.

Quarterly Report

Quarterly Report

The expectations of other financial analysts is also worth noting. After a massive increase in sales growth in 2022, most analysts are expecting a decline in sales growth. However, the EBITDA margin and operating margin are expected to remain at the double digit. Most analysts are expecting an EBITDA margin between 61% and 46% with positive net income.

Marketscreener.com

Marketscreener.com

Finally, the most interesting, in my opinion, is that free cash flow will likely turn positive from 2022. Investment analysts are expecting FCF/Sales close to 31%-41%, which is quite beneficial considering previous results. In my view, at the end of 2022, as soon as market participants see the free cash flow turning north, the demand for the stock will likely increase.

marketscreener.com

marketscreener.com

Balance Sheet

As of June 30, 2022, TORM PLC reports $1.83 billion in vessels and capitalized dry-docking, cash worth $157 million, and total assets worth $2.4 billion. The asset/liability ratio is close to 2x, so the balance sheet, in my view, appears quite solid.

Earnings Report

Earnings Report

Earnings Report

Earnings Report

TORM PLC reports borrowings worth $910 million and $133 million in short term borrowings. Considering the value of the vessels, I am not afraid of the total amount of debt. At the end of the day, the net debt/EBITDA is close to 2x, and the net debt/2023 FCF may be close to 3x-4x. I believe that as soon as TORM obtains new free cash flow, management may decide to reduce its debt levels.

Earnings Report

Earnings Report

Under Conservative Assumptions, I Believe That The Fair Price Would Stand At Close To $39 Per Share

In my view, if the free cash flow continues to trend higher, management may execute further investments in vessels and scrubbers. In one of the most recent reports, TORM reported its intention to order additional scrubbers. As a result, under normal circumstances, shareholders will likely enjoy a gradual increase in both the revenue and the net income per share.

As of 30 June 2022, TORM had installed 51 scrubbers out of 60 planned, including scrubbers installed on purchased second-hand vessels. After Q2 2022, TORM has installed one additional scrubber and acquired TORM Hannah which is fitted with a scrubber. Further, TORM plans to order eight additional scrubbers, which will result in TORM having a total of 68 scrubbers installed on our vessels. Source: Interim Results Presentation

With more cash in hand from operations, management may decide to reduce its debt or increase dividends. In any case, I would be expecting a decrease in the cost of equity or the cost of capital, which would most likely lead to an increase in the weighted average cost of capital. The results would include an increase in the DCF valuation. According to Bloomberg, the container shipping market is expected to grow at a CAGR of 8.6% until 2027. With this in mind, in my view, TORM PLC will, under normal circumstances, grow at somewhat close to the growth of the market.

Container Shipping Market is valued at USD 5.01 Billion in 2017 and is expected to reach USD 11.40 Billion by 2027 with a CAGR of 8.6% over the forecast period. Source: Bloomberg

If we assume, from 2022 to 2032, an EBITDA margin close to 46% and 51% and an effective tax of 22%, 2032 NOPAT would stand at around $475 million. I also assumed capital expenditures/sales close to 11%-9% and working capital/sales of 3%. The results would include free cash flow of $437-$549 million and FCF/sales above 26%. I believe that these numbers are conservative.

Arie's DCF Model

Arie’s DCF Model

If we assume that the WACC would decline from 7.8% to around 4.9%, the discounted free cash flow would stand at around $214-$240 million. Finally, with an exit multiple of 7x, the implied equity valuation would be $3.206 billion, and the fair price would stand at $39.

Arie's DCF Model

Arie’s DCF Model

Worst Case Scenario

TORM PLC communicated to investors that the company was no longer doing business with Russia. The company noted that the invasion didn’t affect its business model, but I wonder whether supply chain issues or changes in the price of oil and gas may affect TORM. Experts did note that the war contributed to the recent increase in the oil price, which may deteriorate the company’s free cash flow. In sum, further increase in the price of oil as a result of the war would be detrimental for TORM’s stock price.

Clearly, the war continues to increase pressure in the system. Some analysts say that the risk of disruption to supplies has not yet been fully priced in and we may be poised for further run upwards. Source: How does the war in Ukraine affect oil prices? | World Economic Forum

Torm has maintained the commitment we made when Russia invaded Ukraine to suspend all new business with Russia. Further Torm has not experienced any critical incidents or situations due to the invasion, meaning that the safety of our seafarers has been unaffected. Source: Interim Results Presentation

I also believe that the recent demand softening recently observed in the United States could lead to a significant decrease in demand. Besides, COVID-19-related lockdowns in China and significant changes in refinery margins will likely lead to a decrease in future EBITDA and free cash flow. Management offered an explanation about these matters in the last annual report:

Demand softening was, nevertheless, observed in the US where record-high gasoline prices brought gasoline consumption to below last year’s seasonal levels, after hovering around 9% above the 2021 levels in Q1 2022. Similarly, COVID-19-related lockdowns in China resulted in the country’s oil demand falling to 2m b/d below the levels seen a year ago. Refinery margins climbed to new highs as concerns about supply tightness of especially diesel pushed product prices further up, at the same time as crude oil prices did not see similar increases. Source: Interim Results Presentation

Finally, I believe that shareholders could also suffer from vessel accidents, maritime safety threats, or changes in environmental laws. In the worst case scenario, I think that one of these risks would lead to a decline in profitability and stock price declines.

10-k

10-K

Under detrimental conditions, I included -15% sales growth in 2023, -20% sales growth in 2024, and 5% sales growth from 2025 to 2030. Also, with an EBITDA margin around 41% and operating margin of 25%, 2032 NOPAT would stand at close to $210 million. Under these conditions, I obtained an FCF/Sales of 24% and 2032 FCF close to $250 million.

Arie's DCF Model

Arie’s DCF Model

With a constant discount of 7.5% and an exit multiple of 6.5x EBITDA, the equity would stand at around $1.25 billion. The results would also include a fair price of $15 per share, and IRR would stand at -2%.

Arie's DCF Model

Arie’s DCF Model

Conclusion

With many years in the shipping industry, TORM recently surprised investors with a significant increase in time charter equivalent rates. The numbers for Q2 2022 were quite impressive, and management indicated that Q3 2022 figures are expected to be beneficial. With these figures, many analysts are predicting a significant increase in free cash flow from 2022 and 2023. In my view, even considering risks from oil price increases, accidents, or regulatory changes, the company remains undervalued.

Be the first to comment

Leave a Reply

Your email address will not be published.


*